Back-seat driving AstraZeneca

Just for fun, here's some quick thoughts on how AZ can get back on track after the reign of CEO David Brennan, who announced his early retirement last week while being water boarded by the AZ BoD:

(btw: I really wanted to label Brennan's tenure as disastrous, but that's not fair. Compared to the return on the S&P 500 and PPH (a big pharma ETF) over Brennan's reign (Jan '06 to now), AZN was very bad, but not atrocious. Take a look:

Live link to chart.

During Brennan's tenure, (as of the day of Brennan's retirement announcement,) AZN was down 5.5%, vs +11.4% for the S&P and +6.8% for PPH. I expected the AZN relative performance to be much worse.

Comparable figures since the Astra-Zeneca merger in 1999:

AZN: -10.3% (total)
S&P: +8.2%
PPH: -14.4%

So, you could say that the AZN merger didn't destroy (relatively) as much value as the pharma industry did over the same time period, but I still can't bring myself to say that it was a worthwhile deal.

In case you're wondering, AZN is <5% of the composition of PPH.

Back to the backseat driving. Here's 8 ideas to get AZN back on track:


1. R&D strategy: go big, or go home. AZ's annual R&D spend is $4.5B, which is only ~40% of the amount AZ annually spends on SG&A. For all of AZN's problems, they still have $11B in cash on hand and throw off nearly $8B in annual operating cash flow. It is time for AZ to either double down on their R&D, or dismantle it.

Everyone knows AZ's pipeline is thin. If it is because the $4.5B of R&D is unproductive, shut down/shrink R&D.

For the last decade the trend in pharma has been to shrink R&D, but the only way that AZ is going to reverse their fate is swim against the tide and massively expand the R&D budget. This option is especially attractive to AZ because of the European R&D assets shuttered over the last decade, and now available for a song. For example, AZ could re-open Pfizer's former R&D facility at Sandwich, UK, attract a very talented team, and likely win government financial assistance in doing so.

There are two counter-arguments to "going big" in R&D - the fact that payoff from the increased R&D is years off, and the fact that EPS would take an immediate hit. I'd argue, though, that the benefit of the increased R&D investment would be felt pretty quickly, as much of the investment would be in downstream clinical development, and not necessarily in basic discovery.

As for EPS, yes, it would take a hit, though not as bad as the gross increase in R&D, as the tax authorities would be paying roughly a third of the gross increase. I'd also argue that perversely, the R&D spend would INCREASE the amount of economic value added annually by AZ, as you'd be replacing the meek interest income from the $11-19B cash on hand with (hopefully) dynamic returns from R&D.

2. Sell Iressa to NVS or another interested party. Iressa (EGFR inhibitor) probably never got enough corporate attention once it landed in regulatory limbo. There's still value to Iressa to to unlock, though, and I think NVS could make the most of the product amidst their other successful targeted cancer therapeutics. (Of which they lack an EGFR inhibitor.) I also think having a new set of eyes to look over Iressa's clinical results would be beneficial.

3. Focus the MedImmune/biotherapeutics group on biosimilars. The combined MEDI and Cambridge Antibody assets are formidable though underutilized engines, both in terms of capabilities and capacity. Why not leverage both in pursuit of biosimilars, as Pfizer is doing with some of their bio-production assets? This is an area where AZ could take the lead, based on their MEDI investment, and an area with a modest capital demand. It would certainly be cheaper to spend another $500M on additional MEDI R&D to develop saleable products than to spend $5-6B in capital to acquire Amylin - a good, though one-market (diabetes) company that doesn't match well with AZ's existing portfolio.

4. Seek more big-big partnering, as exemplfied by the deal with AMGN. (See "AMGN & AZN get creative.") Points #1 and #3 are all about refilling the product pipeline with internally developed "upside." Another route to the same outcome is to buy large chunks of upside to augment the weak AZ pipeline. Combining points 1, 3, and 4 would diversify the R&D risk for AZN and fatten the pipeline, with good cost control.

5. Avoid the urge to make late-stage acquisitions to fill the pipeline. Congrats on the Ardea deal, but please don't think a string of acquisitions is the cure for what ails AZ. Any acquisition right now would represent paying full price, as every other pharma company is shopping hard for late stage products. AZ isn't big enough to outbid PFE, not specialized enough to win many niche acquisitions, and is too desperate at this point to NOT overpay sooner or later. Instead:

6. Climb the risk curve and make early (-er) product development partnerships. Whereas EVERY big pharma has the financial wherewithal to make a bid for a late-stage clinical candidate, many pharmas are too risk-averse to pursue partnering early programs. This represents an opportunity for a big pharma willing to take on more risk AND represents the best return on R&D dollars. Why spend $5-6B on an acquisition like Amylin or $1.2B on a late-stage deal like Ardea when AZN can probably sign and fund 10 early stage partnerships for a fraction of these amounts?

One other consideration: AZ's new CEO probably has 3-4 years to make an impact at AZ, which is enough time that a Phase I lead gained through partnership now can become an exciting Phase III product.

7. Recognize that there is a historically massive opportunity for AZ, and concurrently cut the dividend. There has never been a better time to be in the drug discovery & development business. Incomes are rising around the world while populations are aging. At the same time, medical knowledge has exploded over the last decade, and emerging technologies (e.g. in silica screening) are making drug discovery easier, less costly, and less risky.

It has been a long time since AZ or most any pharma was a growth stock, but with the context above, why wouldn't you want to transform AZ into a growth stock, and increase investment in R&D, as funded by reducing or eliminating the dividend? Yes, changing the dividend will set off alarms in the financial community, but better to do it proactively as part of a growth strategy than reactively once everything goes off patent.

8. Quit pretending that AZ decisions aren't heavily influenced by geography and political concerns by relocating corporate HQ to……….Dubai. AZ's HQ is in London. Except R&D, which is based in Sweden. And except UK R&D, based in NW England. And except biologics, based in Maryland. And except their biggest office in their biggest market, in Delaware.

Some tech companies see geography as a competitive necessity, such as the growing big pharma labs in Cambridge, MA (PFE, MRK, NVS….) AZ goes so far in the other direction, that you wonder if they are intentionally avoiding tech hotspots. UK R&D in Cheshire, UK instead of Oxbridge? Swedish R&D not near the Karolinska Institute? Weird.

You just know that decisions aren't made at AZ solely on their merits and without considering the geo-political ramifications. One way to negate this is to relocate corporate HQ to a "neutral" territory, and publicly commit that future UK & Swedish investment will be tied to leading academic locations. I'm not saying that AZ's weak R&D productivity is due to their location in NW England, but I believe that one way to boost the R&D productivity is to gain more exposure to leading labs in Oxbridge and the Karolinska. Watch AZ's R&D be reinvigorated.

Dubai is a silly answer to "what's a neutral country roughly equidistant to the UK and Sweden?" but I'm sure Dubai or other countries would provide a huge economic incentive to support the corporate relo. Not only would Dubai or others pay a bounty for the influx of meaningful jobs, but you could probably find a country that would be convinced to pay BIG $$$ so that AZ could become the cornerstone of their nascent pharma industry. If Boeing could relocate their corporate HQ from Seattle to Chicago, AZ sure could move to Dubai, or Singapore, or Bangalore.

(not to mention that there could be a substantial savings in corporate taxes for AZ.)


So there's my quick, under-informed ideas to get AZ back on track. Unfortunately, to make real backseat driving recommendations, you have to ignore certain realities, such as the holiness of the EPS expectations, and the tax advantages of filling the pipeline via acquisitions rather than increasing the R&D cash expense. But, you read this far, which means that there's some value in my backseat-driving recommendations…….

AMGN & AZN get creative

Suspicions are often aroused when two of the biopharma "big boys" partner up. Is the company originating the technology trying to hedge their bets and take some money off the table? Is the 'buying' partner inadvertently saying that their R&D efforts are inferior to their new partners'?

I would ignore the doubts in the case of last week's announced partnership between AZ and AMGN. The 2 companies will work together to develop 5 different anti-inflammation biologics, splitting costs and program responsibilities. The prospective costs and benefits are measured in billions.

Abbott's Humira (anti-inflammation biological) is a $9B product. No need to be greedy with a market that big. Both AZ and AMGN increased the chances of gaining a slice of that market, with the risk & costs roughly halved. Where some analysts are sour on the tie-up, I think it is good risk management, and I'd like to see more deals like these rather than less. (I also think this is very creative. More of that too, please!)

I like the deal a lot, but I'm not too sure that Wall Street does. Here's a quick look at how both stocks have performed in the <2 weeks since:

(Link to dynamic GOOG finance chart.)

So, AMGN is down with the market, AZ up 1.2%, so perhaps the Street thinks this is a win for AZ, and nothing new for AMGN.

I think the stakes for these two companies are higher than most recognize. For AMGN, this deal preserves their independence for a half of a decade. Without a partner, AMGN would either be betting the company on their inflammation program, or pruning the five programs just to save cash (or both.)

For AZ, they've just fattened their pipeline with high leverage R&D assets. If you believe that the cost of getting a drug to market is largely static independent of market size, AZ just gained some mid-stage leads that only cost half as much as usual to bring to market and while they only get half of the upside, halving a ginormous market 9X larger than a 'basic' blockbuster while halving the costs is a GREAT trade.


(Side note: I wonder how it would look if we similarly evaluated pharma pipelines not for risk adjusted expectations, but instead as a ratio of upside$ per R&D investment $. I'll put a little more thought into this, as my quick guess is that GENZ's rare disease approach would rank dead last in terms of upside per R&D dollar, even though we know it is a great business for them.)

Carl Icahn: net positive or negative for the biotech industry?

I can't decide if Carl Icahn's activism in the biotech sector is a good thing or a bad thing. On one hand, his insight, activism, and capital drives stock appreciation in the biotech sector. (And even just his interest in the sector is a good thing.)

On the other hand, no one is more responsible for making mid-cap biotechs an endangered species.

I first looked at this five years ago on the Xcovery blog (Wanna scare a CEO? Just say these 7 words: "Mr. Icahn is holding on line 2.") At the time, Icahn was agitating for the sale of MedImmune, and had recently bagged ImClone. Since then, he's a had a big influence in the sale of Genzyme, and made runs at Biogen and Forest Labs. BIIB and FRX raids did not conclude with a company sale, but both companies had bumps in stock values due to Icahn, and a big profit for Icahn.

Now Carl Icahn is chasing Amylin.

On my old blog I listed 10 reasons why Icahn's interest may be a net positive, and they're worth another look:

1. Interest by corporate raiders validates the biotech industry as viable businesses, rather than a collection of high-risk experiments.

2. Raider interest will attract other sources (non-alternative investments) of capital sends the message that biotech may be volatile, but not necessarily risky. (As opposed to the current notion that biotech is risky, but not necessarily volatile.)

3. Corporate raiders will keep biotech more slim and agile versus big pharma. (Though I've heard rumblings that some hedge fund could take down a pharma one of these days, so maybe this edge won't hold for long.)

4. Raiders force target companies to focus on "what's next," rather than complacently focusing on the sales and marketing of existing products.

5. Raiding will bring about needed consolidation among mid-sized biotechs, as the raiders view the overhead for companies at this size as a bad investment.

6. Raiders will increase the amount of business discipline within the industry. (And likely instigate management turnover, which could also be management evolution.)

7. Raiders will increase attention on the biotech industry.

8. Biotech has (and probably will always be) a game of capital raising. Raiders will bring more capital to the biotech industry, though the capital will tend to be higher-velocity.

9. Attention to financial returns by biotechs will increase among industry folks, as raider interest is in part related to the very high margins earned by biotechs. The high margins decrease risk for raiders, and can generate large amounts of incremental cash to justify raider transactions, if the margins are believed to be improvable.

10. Raiders (and other private equity types) may innovate new vehicles to finance biotech. One of these 'innovations' is quite old, but new to the biotech industry: dividends. (Icahn, in particular, often presses target boards to increase their dividend to drive stock prices.)




In retrospect, I think the label "raider" is harsh and inaccurate - Icahn certainly has high short term expectations, but I think he's also well-intentioned, trying to find the best home for at-risk, underperforming assets. He's not squeezing companies to cut staff to take more cash out of a target, or leaving behind half-dead Zombie companies, but rather hastening the process of smaller company selling out to big.


However, as a result, there are less small-to-mid biotech's left, meaning there's a "lost generation" of companies that could aggressively or reasonably re-invest in early-stage biotech, thus having the knock-on effect of impeding early biotech. (Historically, mid-cap companies have been less risk-averse than big pharma when it comes to partnering with smallish/early biotech. Plus, focusing on fending off Icahn's advances takes attention and capital away from planting partnership "seeds," and may make a mid-cap less attractive to a potential partner.)


The counter-argument that Icahn might make is that capital gains from his activities generate more capital to be invested in the biopharma sector at all stages. I think, though, that the law of supply & demand trumps all: reducing the number of potential "buyers" of early stage tech (i.e. GENZ, IMCL, etc.) drives the prices down on such tech/leads.


There's one other way to look at this that is very much to Icahn's credit: economic impact. Since selling MEDI to AZN, MEDI's footprint in Maryland (MEDI's home) is much, much larger, as they've become AZN's biologics center of excellence (CoE), and it seems that GENZ is also likely to similarly expand in Boston as a CoE for Sanofi. If Icahn's activism provided purely return on capital (rather than labor or assets), you'd see talent and IP sucked up into the corporate parent, and a diminished physical presence as the acquirer cut costs. This was pretty much the case with IMCL, but that might be a factor of Lilly's management style, as much as anything else. (An entrepreneurial NYC company and a starchy midwest giant don't make for a great pairing.)


Ultimately, your opinion of Icahn's impact in the biotech world likely depends on who you are. If you're a shareholder at a target company, you like him a lot. If you're an executive at a target company, you definitely wish he'd go away.




Finally, while this post is centered on Carl Icahn, it is important to note who else has been a key player on Team Icahn, and now on his own: hedge fund manager Alex Denner, who is credited with generating $2B in profits (or is it value?) while chasing under-appreciated biotech stocks, mostly with Icahn.


related: Amylin (AMLN) management: BUSTED!

R&D efficiency

Forbes' Matt Herper takes a look at the cost to develop a new drug, and now current estimates put that figure at $1B-$4B.

While the current estimate is newsworthy, folks at places like Tufts have been conducting this exercise for years, and the numbers are always eye-popping (and debatable.)

What makes this particular article interesting is how you can also use the analysis conducted by Herper to compare pharma productivity over the last 15 years. Take a look at the R&D productivity of the top 12 pharmas:

Here's my takeaways:

-There's two tiers of productivity in the analysis: the "productive" cluster (AMGN, NVS, BMS, MRK, ABT, and LLY) all cluster between $3.7B and $4.6B in cost per new drug, while the "less productive" ranged from $5.9B to 11.8B per drug. While half of the companies studied, the "productives" account for 66 of the 135 drugs (49%) these 12 companies introduced in the last 15 years. So you can't say that higher R&D productivity is also a factor of scale - the productive and less-productive companies produced roughly the same number of drugs. 

-The "less-productive" companies tend to be the product of mega-mergers. Each of these companies has done deals to one extent or another, but think of the "biggies" and you're generally thinking of the "less productive" group. Careful, though, when thinking about the time element here - MRK, for example, only did their big SGP acquisition in late 2009. This brings up the question: do mergers depress R&D productivity, or is it mostly companies with declining R&D productivity that have the urge to merge? (My guess: a bit of both, but considering that the 6 most productive companies are generally considered the least involved in the M&A game due to a bias towards internal efforts, it may be a moot point. M&A either distracts from focus, or results in sub-efficient R&D orgs.

(I'm being charitable to NVS, which is a product of a mega-merger (Sandoz and Ciba-Geigy), but that occurred in 1996 - prior to the analysis period. Either NVS did a much better job of integrating R&D, or it takes 15 years to overcome the M&A inefficiencies.)

-I think it would be appropriate to believe that these results also project future R&D efficiency and likely future stock performance.  (e.g. over the next 15 years, AMGN is likely to be much more productive than AZN.) The 15 year period (and $75B in R&D spend) should account for short-term spikes and likely demonstrates which companies have the best R&D people and organizations. I am especially impressed with Novartis (21 products over 15 years) and most disappointed by AstraZeneca (5 products over the same period.) Perhaps this reflects one company choosing easier/harder targets, but I think it more likely reflects capabilities.

-For all of the news and criticism, Pfizer's R&D isn't too bad. The criticism that failures like torcetrapib reflect diminished R&D productivity due to repeated mergers seems misplaced, as Pfizer was almost middle-of-the-pack in R&D efficiency over the last 15 years.

-You might expect that the broadest R&D portfolios would have the smoothest results (success in one area, say cancer, making up for failures in another, say neuroscience.) However, the more productive companies are to me the least broad. Rightly or wrongly, I think of BMS & AMGN biased towards cancer research, while GSK and JNJ are the most diversified. Does this mean that there is R&D value in specialization?

Any other insights to be gleaned from the Forbes analysis?

A couple of caveats to the analysis: 

-The best analysis would weight productivity with resulting product sales. (In other words: you'd accept lower R&D spending efficiency if the output were blockbusters.)

- I can't tell from the Forbes analysis exactly what is included in the figures. I suspect that Roche data includes historical Genentech R&D spending and output. I think DNA has been one of the most efficient AND effective R&D organizations, so I would be very curious to see DNA split out from pre-merger Roche.